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The $500,000 Life Insurance Gap

Most families say they want enough life insurance to cover 14 years of lost income should the breadwinner die, but they have enough to cover only three years, according to a Life Insurance Gap survey put out by New York Life. That stark difference between perception and reality puts families at great financial risk, says Chris Blunt, co-president of the Insurance and Agency Group for New York Life.

The gap survey looked at the median shortfall between how much life insurance coverage families have in place compared to how much they say they want life insurance to cover in the event of the death of the breadwinner. The median shortfall was $320,000 in 2013, up from $289,000 five years ago. In 2013, the median amount of life insurance coverage families had in place was $220,000 and the amount they said they needed was $540,000. In 2008, the median amount of life insurance coverage in place was much higher at $300,000, and higher needs were reported at $589,000.

Mind/the/gap: Is there a gap between what your life insurance would pay out and what your family needs? (Photo credit: futureshape)

The survey found that the life insurance coverage gap varies by geographic region, with families in the Western U.S. facing the biggest gap of $457,000. The median amount of life insurance coverage in place for families in the Western U.S. is $250,000, compared to $707,000 that they said would cover their needs. The Northeast had the next biggest coverage gap of $334,000, and the South’s coverage gap came in at $302,000. The Midwest had the smallest coverage gap of $229,000–because their self-reported needs at $430,000 were the lowest.

Self-Reported Life Insurance Gap By Geographic Region

Midwest $229,000

Northeast $334,000

South $302,000

West $457,000

The reason for life insurance is to protect your financial dependents–your spouse, children or parents—in the event of your death. While most of those surveyed said they want life insurance to cover funeral expenses, in reality, the greatest need is for income replacement. Imagine paying the bills without the breadwinner’s salary.

The industry rule of thumb used to be to buy life insurance that would provide 7 to 10 times your salary. More recently the high-end recommendation has been doubled to 20 times your salary, depending on your circumstances. But the number really depends on what you need the life insurance to do: to cover annual living expenses, to pay for day care through college expenses for your children, to pay off your mortgage or other debts, to help your spouse with transition income for a number of years—or income for life.

Do you have a gap in coverage? One way to check is to start with an online calculator like the one New York Life has here or a more detailed one the American Institute of CPAs has here.

The good news is that life insurance is relatively cheap. For term life insurance, you pay a set amount each year, typically for 20 or 30 years, for a guaranteed benefit (the tax-free payout if you die while the policy is in force). For a healthy 35-year-old male, it would cost about $220 a year for a 20-year term policy with a $250,000 death benefit. (My family is covered with term policies from Reliastar purchased through Accuquote.com.)

The danger with delaying the purchase of life insurance, or dropping it as many people did during the great recession and then having to reapply for it, is that it’s typically more costly to buy when you’re older, just because you’re older. And if you have any medical issues that change you from preferred “superman” or “superwoman” status to non-preferred (say you’ve taken up smoking or scuba diving, been convicted of reckless driving or your bad cholesterol levels are up), that will cost you.

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